Global Economy & Markets, Weekly Roundup 10/05/22

The Federal Reserve anticipates that ongoing increases in the policy rate will successfully engineer a soft landing for the US economy 
              
Key Takeaways
 
The Fed increased the federal funds rate by 50 bps to +1.0%, as expected, on May 4th. Ongoing increases in the policy rate will be appropriate, as the Fed is determined to move expeditiously to bring “much too high” inflation back down. 
 
According to the FRB Cleveland’s Inflation Nowcasting model, headline CPI inflation (due on May 11th) is expected to decelerate to +8.1% yoy in March from a 40-year high of +8.5% yoy in March. The core index is likely to ease to +6.1% yoy (+0.5% mom) from +6.5% yoy (+0.3% mom), in a big part due to base effects.  
 
Finally, the Fed announced the start of the reduction of its balance sheet of $8.9T or 38% of US GDP by circa $1T per annum. Tightening will start on June 1st via non reinvestment of maturing securities ($47.5B) and will accelerate to a maximum monthly pace of $60B (US Treasuries) and $35B Agency MBSs by August. 
 
The pace of monetary stimulus removal will accelerate, as, inter alia, the US labor market is extremely tight. The US unemployment rate was steady at 3.6% in April (pre-pandemic: 3.5%), while the labor force participation rate declined by -0.2 pps to 62.2%, hovering meaningfully below pre-pandemic levels of 63.4%. The job openings rate at 7.1% and the quits rate at 3% (the number of quits during the entire month as a percent of total employment) hover at record-high levels. 
 
The narrative of tighter monetary policy amid exogenous growth risks (pandemic-related local lockdowns in China, Ukraine war) hurt risk appetite in the past week, despite a --short-lived-- relief rally on Wednesday, following Chair Powell’s comments that the committee is not actively considering a 75 basis points interest rate increase per meeting. 
 
All told, large cap US equities have declined by -3.4% in May (-17% since January high of 4797). Mega-cap tech names sold off, also due to underwhelming earnings results (Netflix, Amazon), with the Nasdaq Composite in bear market territory (-28% since November 2021 high). 
 
Government bond yields increased significantly in the past week, with the 10-Year US Treasury yield increasing by 24 bps to 3.13% and surpassing the 3% threshold for the first time since November 2018. Euro area core bond yields rose in tandem (10-Year Bund: +21 bps to 1.11%, highest since August 2014), with periphery bond spreads widening across the board. 
 
The Bank of England (May 5th) increased the Bank Rate by 25 bps to 1%, as expected. The move came with a vote majority of 6-3, with the dissenting members opting for a 50 bps hike. Regarding economic projections, the BoE foresees 2-digit inflation on average in Q4:2022 (+10.2% yoy) from 7% currently, when hikes in energy bills will have fully materialized. 

Note that BoE expects that the ensuing shock for disposable incomes will lead to a small contraction of GDP in Q4:2022 (-0.9% qoq│+0.7% yoy), followed by average quarterly growth of +0.1% qoq in 2023 (+0.2% yoy in Q4:2023). The BoE’s bleak economic outlook led the British Pound substantially lower, by 1.6% wow against the US Dollar to $1.235 (the lowest since June 2020) and by 2% wow against the euro to €/0.857 (its lowest since December 2021). 
 
 
Global Economy & Markets, Weekly Roundup 10/05/22
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